Effective financial planning has to be accompanied by consideration and discussion of risk—but risk is so multifaceted it can be difficult to discuss with clients.
“I believe risk is a many-headed hydra and that there are many ways that people perceive and deal with risk,” said Mark Odo, Client Portfolio Manager for Swan Global Investments. “For our clients, our philosophy is the biggest risk a lot of investors face is the risk of a major market drawdown by 30%-40%-50%.”
Swan Global Investments is a hedged equity firm that offers advisors a variety of hedged-equity solutions across mutual funds, ETFs and separately managed accounts. Odo is responsible for helping clients and prospects gain a detailed understanding of Swan’s Defined Risk Strategy, including how it fits into an overall investment strategy.
While stocks dropped by more than 30% in March of 2020 as the coronavirus pandemic gripped the world, that bear market was extremely short lived and indexes quickly resumed posting new records. It hasn’t been since the global financial crisis of 2007-2008 and the subsequent lows of the great recession that U.S. investors saw their last 50% market decline.
When Swan asked investors which concerns them more, the equity market or the fixed income market, many people couldn’t decide, Odo said.
“On the fixed income side, the bond market is out of gas after being a fantastic investment over the last 40 years,” said Odo. “Its traditional role of providing capital preservation and income is unlikely to continue going forward. You can have capital preservation or yield, but not both. With inflation on the rise, fixed income faces even more challenges.”
Equities, on the other hand, experienced what Odo views as an unsustainable advance over recent years, to the point where valuations are stretched and investors expect a more challenging environment moving forward.
Most investors, steeped in the wisdom of allocating to a balance between equities and fixed income, are faced with a difficult dilemma given rising inflation and current valuations.
Other Dimensions of Risk
Robert G. Gilliland, Managing Director and Senior Wealth Advisor for Concenture Wealth, said that the risks that have the most behavioral impact on his clients are related to retirement. He founded Concenture, an independent advisory, to ensure that his efforts would be focused solely on helping clients achieve their goals, without the constraints of corporate mandates. At Concenture, Gilliland has helped launch Six Degrees Wealth Management in partnership with Sanctuary Wealth to provide RIA-minded advisors with exit strategies
“When I think about risks, I think about what clients are fearful of,” said Gilliland. “People across the board continually note two things that they are fearful of: costs of healthcare as they get older and the possibility of outliving their money. You have to go through and manage these concerns if they assume it is a risk.”
These risks are distinct from the measure of risk within portfolios, which is volatility.
Gilliland uses a bucketing approach to create retirement portfolios, assigning conservative growth rates to near-, mid- and long-term buckets to help prevent clients from making bad decisions.
“That doesn’t mean the portfolio you see today is going to be the portfolio you see in six months, but you do have to plan what their income needs will be and stress test that,” said Gilliland. “I make sure that they understand that outright, and then review and track our progress as we go through their plan.”
Ariel Acuña, President at LTG Capital, has also seen an increase in awareness of longevity risk. Investors need to understand that there’s a dichotomy at work: either they will outlive their money, or their money will outlive them.
“You go through most of your life working for a paycheck, and when that is not there anymore, you have to transition to living off your savings,” said Acuña. “That is difficult to comprehend. We make sure there are sufficient savings and emergency cash reserves. Not being prepared for any large expenses can ruin any plan.”
He then stress-tests portfolios against historical examples of market drawdowns.
LTG Capital is a fee-only RIA that is in the process of transitioning from a firm that primarily serves individuals to working solely with other IRAs and institutions to allow them to access differentiated investment strategies.
A New Era of Investing
For the last 10 years, it’s been very easy to invest, said Gilliland, as pursuing low-cost investing strategies and passive asset allocation was usually sufficient for success.
“Now we have to communicate to clients exactly what the game plan is and make sure they know that we have a plan in place if something happens,” he said. “From a client standpoint we have to communicate to them in the manner and cadence that they want.”
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